Investing News

We continue to expect
housing may add to GDP
growth in 2015 and for
the next several years,
as the market normalizes
following the severe
housing bust of
2005 – 2010.
Poor weather in Q1 2015
may again cause housing
to be a drag on growth
early in 2015.

The market’s continued
ascent has caused
some to ask if the stock
market reflects
excessive optimism.
The pace of economic
surprises as measured by
the Citigroup Economic
Surprise Index suggests
expectations remain
reasonable.

We are watching
several key factors to
assess the potential
opportunity in the
energy sector.
While we expect to try
to take advantage of
opportunities in this
group in short order, we
are not convinced that
it now presents a great
entry point.
We continue to
recommend the
consumer discretionary
sector, where suitable,
as a way to play low
energy prices.

The market continues to
expect that global GDP
growth will accelerate
in 2015 and 2016, aided
by lower oil prices and
stimulus from two of the
three leading central
banks in the world.
The consensus has been
raising its estimate for
2015 growth for developed
economies and sharply
lowering its estimate for
emerging markets.

look at some of the
highlights and lowlights
of fourth quarter
earnings season.
Despite the massive drag
from the energy sector
and the negative impact
of a strong U.S. dollar,
fourth quarter 2014
earnings are on track to
exceed prior estimates.

Although it is too soon
to gauge the
effectiveness of QE in
the Eurozone, key
readings and data are
beginning to show
improvement, and
consensus expectations
are for continued
growth in 2015.
However, market
participants looking for
an immediate and
sustained response by
the Eurozone economy to
QE may be disappointed.

The stock market fell in
January, causing some to
ask whether the so-called
January effect means
that stocks will fall
this year.
Recall less than four
weeks ago the “first five
days” indicator sent a
positive stock market
signal for 2015.
We always put
fundamentals first when
forecasting stock market
direction—and on that
score, we believe stocks
still look good.

The market is expecting
the economy to add
235,000 net new jobs in
January 2015 and for the
unemployment rate to
remain at 5.6%.
Other measures of the
health of the labor
market — hiring rates, the
quit rate, the
unemployment rate, and
most importantly,
wages — still show that
the labor market is not yet
back to normal.

The latest leg up for the
U.S. dollar has been
driven by anticipation and
arrival of QE by the ECB.
The dollar has been
strong for a number of
reasons, all of them
good things.
Though not the end all
and be all, currency is an
important consideration
when determining
asset allocation.

The pace of growth in the
global economy is a key
driver of global earnings
growth, and ultimately,
the performance of global
equity markets.
The IMF raised its
estimate for growth in
2015 for developed
economies and sharply
lowered its estimate for
emerging markets.

The latest Beige Book
reflected a picture of the
U.S. economy that was
largely unaffected by
concerns over dropping oil
prices, the 2014 holiday
shopping season, global
growth scares, and a
rising U.S. dollar, although
the drop in oil prices was
noted as a negative in
some districts.

The much anticipated
European Central Bank
(ECB) policy meeting this
week may include a
quantitative easing (QE)
program announcement.
Although we would view
a potentially bold QE
program from the ECB as
an incremental positive,
the ongoing growth and
deflation challenges in
Europe leave us still with
a strong preference for
the U.S.

The U.S. economy
created another
252,000 net new jobs in
December 2014 and 3
million over the course
of 2014, with the most
net new jobs added
since 1999.
The labor market still
has a long way to go to
get back to “normal,”
which may keep the Fed
on hold for raising rates
until late 2015.

Earnings season is here
and the impact of low
oil prices will be the
market’s main focus.
While we will be closely
monitoring the energy
sector, we will also be
watching the sectors and
industries that potentially
benefit the most from
cheap oil.
The consumer
discretionary sector and
the transports are big
potential beneficiaries,
supporting our positive
views of both groups.

This week we examine
how the U.S. economy
in 1985 compares with
2015, focusing on
factors such as the pace
of the current economic
expansion, the political
balance in Washington,
consumer sentiment,
and the role of the Fed’s
monetary policy.

The impact of falling oil and energy prices on
inflation, inflation expectations, the U.S. and
global economies, and the global financial
system received a great deal of attention at
the eighth and final FOMC meeting of 2014.
Fed Chair Yellen’s comments during the
post-FOMC press conference seemed to have
calmed fears regarding the negative effects of
oil’s drop on the financial system.

Statements following the final FOMC meeting
of 2014, particularly on the recent drop in oil
prices and its impact on the U.S. economy,
could have ramifications for near- and longterm
monetary policy.
The FOMC will also provide markets with a
new set of targets at this meeting...

We expect holiday shoppers, bolstered by
lower energy prices, to help support potential
stock market gains.
Although the severity of the oil price decline
has been unsettling, we view the decline as
positive for U.S. consumers overall.
Retail stocks should deliver some cheer for
markets this holiday season, but don’t stuff
those stockings with too much of them.

We expect the policy environment in 2015 to
be supportive for stocks.
The transfer of power to Republicans may have
a meaningful impact on broad policy measures.
Regardless of the political party in power,
the year before the presidential election has
historically been a good one for stocks.

The report suggested that U.S. economic
activity has “continued to expand,” and in
general, optimism regarding the economic
outlook far outweighed pessimism, as it has
for the past 18 months or so.
For the first time in this business cycle,
the latest Beige Book contained more than
one mention of employers having difficulty
finding low-skilled workers, and retaining and
compensating key workers.

We believe stocks will deliver mid- to highsingle-
digit returns in 2015.
We expect earnings, and not valuations, to do
the heavy lifting in producing potential stock
market gains for investors in 2015.
Monetary policy is in transit in 2015, when
stocks will face a shift from the very loose
monetary policy of the Federal Reserve’s
(Fed) quantitative easing (QE) program to an
environment in which the Fed begins to hike
interest rates.
Valuations for the S&P 500 remain slightly
above long-term ave​

We believe the U.S. economy will continue
its transition from the slow gross domestic
product (GDP) growth of 2011 – 2013 to more
sustained, broad-based growth.
We expect the U.S. economy will expand at
a rate of 3% or slightly higher in 2015, which
matches the average growth rate over the
past 50 years.​

We believe emerging markets (EM)
fundamental conditions are set for
improvement in 2015, based on our outlooks
for economic growth, earnings, and policy.
Valuations are compelling and EM may be
situated to recapture some of their relative
losses from a technical perspective, particularly
in Asian markets.
However, somewhat mixed fundamental and
technical pictures suggest a better opportunity
may be forthcoming.

The much weaker than expected Q3 GDP
reading in Japan is a modest threat to overall
global growth for 2014 and into 2015.
We continue to believe the global economy will
continue to expand in 2014, 2015, and beyond.
The pace and composition of the policy
response from Japan in the coming weeks
and months are critical.

While the certainty provided by an election
outcome has been positive for the stock
market over time, our positive stock
market outlook is based much more
on fundamentals.
It does not get more fundamental than
earnings, which are on track to grow by 10%
year over year for the second straight quarter.
Earnings season is not over, but with about
90% of S&P 500 companies having reported
results, we are ready to declare it a success.

The drop in gasoline prices over the fall and
summer months has been a plus for spending,
but other factors have a much bigger impact
on the consumer.
The better tone to the labor market, the sharp
rise in household net worth, and prerecession
levels of consumer confidence all act as
supports for the consumer.
However, stubbornly weak wage and income
growth remain as key constraints on spending.
Sustained economic growth is the best way to
ensure solid employment growth.

It is important to recognize that the S&P 500
is not GDP. S&P 500 companies have different
drivers for earnings than the components that
drive GDP.
The backdrop of solid business spending within a
slower trajectory of overall GDP growth can be a
favorable one for the stock market.
Although stocks are at the low end of our target
10–15% S&P 500 return range for 2014, we see
further gains between now and year end as likely,
with profit growth as a primary driver.

The Fed ended its bond purchase program last
week and the bar has been set fairly high for
restarting more QE.
The economy is in far better shape today,
compared with the start of QE in 2008 and
the end of QE1 and QE2.
It is probably too soon to know if QE has
“worked,” and the better question may be, can
the U.S. economy stand on its own without QE?
We believe the BOJ and ECB are likely to do
more QE.

The U.S. economy is improving, and in
many cases is back to normal, but it remains
stubbornly weak in some areas.
“Real world” indicators that point to the
health of the economy include crane rental
rates and customer traffic in restaurants.
Economic uncertainty — likely a drag on
economic growth in 2011, 2012, and 2013 — has
faded as a concern in 2014, consistent with the
Fed’s most recent Beige Book.​

We remain confident in corporate America’s
ability to generate solid earnings growth in the
current global economic environment despite the
slowdown in Europe (and to a lesser
extent, China).
A number of U.S. companies have performed
relatively well in Europe, with some not yet
seeing signs of a slowdown in their business.
The business environment overseas appears
to be good enough for companies to largely
maintain their outlooks for the rest of the
year and into 2015.

We believe the oil sell-off is overdone and expect
the commodity to find a floor in the low $80s.
We expect firming global growth to increase
the market’s confidence in global oil demand
despite weakness in Europe.
Energy service stocks are particularly oversold
and may be attractive as the services-intensive
U.S. energy renaissance continues.

The latest Beige Book reflects a picture of the
U.S. economy that has, thus far, been largely
unaffected by current geopolitical headlines.Optimism regarding the economic outlook far
outweighed pessimism, as it has for the past
18 months or so.

We see the recent increase in volatility as normal
within the context of an ongoing bull market.
We do not believe the age of the bull market, at
more than 5.5 years old, means it should end.
We maintain our positive outlook for stocks for
the remainder of 2014 and into 2015.

The pace of growth in the global economy
is a key driver of global earnings growth,
and ultimately, the performance of global
equity markets.
Global GDP growth in 2014 remains on track
to accelerate versus 2013’s pace, and the
consensus is forecasting acceleration in global
growth in 2015.
Potential growth headwinds in 2015 include...

Earnings season is here and may counteract
the negative headlines with another
dose of positive fundamental news.
We expect the third quarter of 2014 could
produce another good earnings season, which
we believe may positively impact stocks.
While there are some headwinds, Europe
in particular, the U.S. economic backdrop is
supportive and profit margins should remain
high, given the few signs of cost pressures.

The nation’s fiscal situation has improved
dramatically in the past five years due
to overall economic improvement and a
combination of higher tax rates and modest
spending increases.
However, structural and demographic
problems that will drive the deficit over the
next several decades remain in place.
If policymakers continue to ignore critical
warning signs, the near-term improvement in
the budget picture is unlikely to last.

The yield curve has a perfect record in
signaling recessions over the past 50 years.
One of our “Five Forecasters,” the yield
curve tells us that a recession and significant
market downturn are likely a ways off.

We continue to expect housing may add to
GDP growth in 2014 and for the next several
years as the market normalizes following the
severe housing bust of 2005 – 2010.
Housing affordability and supply, and the
supply and demand for home mortgages, will
likely determine the pace at which housing
increases GDP growth in the years ahead.
The inventory of new and existing homes for
sale as a percentage of total households has
never been lower.

Last week we discussed why buying
European stocks now, following the recent
stimulus announced by the ECB, is very
different from buying U.S. stocks during
periods of Fed stimulus in recent years.
This week we take a deeper dive into the
investment opportunity in Europe and evaluate
fundamentals, valuations, and technicals.
We recommend that investors “fight the ECB.”
We do not believe the additional stimulus
is enough for us to recommend European
equities over U.S. equities at this time.

The key now for the Fed, as it deliberates
when to begin to raise rates, is to gauge how
quickly the output gap is likely to close.
The pace at which the U.S. economy
takes up slack is likely to command a great
deal of attention from the Fed and market
participants in the coming months.
We believe the first Fed rate hike is likely to
occur in about a year’s time, assuming the
economy tracks the FOMC’s forecast.

We continue to expect the Fed to again cut
its bond purchase program and remain on
pace to exit QE by year end.
However, odds have increased that the Fed
could change “something” at this week’s
FOMC meeting, including omitting its
promise to keep rates low for a “considerable
time” or providing the public with an update
to its exit strategy.
We are continuing to watch...

We believe the “three Rs” are keys
to the outlook for the stock market:
revenues (and profits), reinvestment,
and the renaissance in manufacturing.
We expect stocks to garner support from
these three Rs in the form of continued
growth in revenues and profits, more
corporate reinvestment, and continued steady
gains for the U.S. manufacturing sector.

Over the past three Beige Books, the BBB
has averaged +100, the highest reading over
any three consecutive Beige Books since at
least 2005.
The latest Beige Book indicates to us that the
negative headwinds that have held the U.S.
economy back over the past seven years may
finally be abating.
Health care and the ACA have remained a
consistent source of concern among Beige
Book respondents, although the impact has
faded a bit recently.
Despite the recent barrage of bad news on...

The market is not expecting the ECB to begin
QE this week, although other forms of policy
support are likely.
The data continue to suggest that more aggressive
monetary policy from the ECB would have only
a muted impact on the real economy unless the
fractured banking system can be repaired.
Policy divergences among the world’s major
central banks are likely to intensify in late 2014
and beyond.

The resolution of election uncertainty — and
ending the predominantly negative rhetoric
surrounding the campaigns — has historically
been a positive for the stock market.
We continue to see opportunities for further
stock market gains over the course of 2014,
based upon fundamentals rather than the
potential for sweeping legislative change.

The first rate hike by the Fed has never been
an indication of a market peak.
On average, the first rate hike has taken place
37% into the economic cycle (measured peak
to peak).
The S&P 500 has returned on average,
another 58% after the first rate hike (price
return) before the market peak for the
economic cycle.
The initial market reaction to a rate hike is, on
average, negative, but the data show it pays to
be invested.

Revisions to GDP don’t often change the
overall picture of the health, or lack thereof,
of the economy.
Despite cutbacks to congressional funding of
data collection at the federal level in recent
years, the GDP data are a lot more accurate
than they used to be.
About every five years, the BEA does a
“comprehensive revision” to GDP, and at that
point, GDP for any specific quarter is just
about as final as it will get, as the BEA has
98% of the data it needs to calculate GDP.

Our fastest growing exports are not always as
visible as some of the items we consume and
import daily.
Most major service export categories have
experienced near 10% growth per year for the
past 10 years.
Good Old American Know-How is our most
abundant resource.

The United States has a trade surplus in
the service sector, where we are creating
relatively high-paying jobs.
Many U.S. service-related jobs require
advanced degrees and advanced skills, and
help to make possible our booming business
in service exports, much of it tied to Good
Old American Know-How.
Our competitive advantage in the service
sector should help to continue to drive
employment higher in this sector, especially
in areas that require advanced skills.

Volume has picked up during the recent downturn. No, we are not talking
about trading volumes; we are talking about the volume from your TVs with
talking heads warning about an impending stock market downturn. If you
turn off the TV and focus on what the market is telling you, rather than the
talking heads, you can tune out the noise.

Losing under 3% in a week seems a minor
concern given historical market ups and
downs; nevertheless, investors may begin
to wonder if stock market valuations are
signaling a decline.
Since the end of the last significant sell-off
for stocks, the market has been in a pretty
consistent upward trend.
Valuation is a poor market-timing
indicator; while valuation should always
be considered, it is a blunt tool that
should be taken into broader context.

With the release of the GDP figures for the
second quarter of 2014 (along with revisions
to the data back to 1999), the disconnect
appears to be fading.
The data released so far for the third quarter
suggest that the underlying economy had
decent momentum as the third quarter began.
The data continue to suggest that the U.S.
economy is poised to post growth in the
second half of 2014 above the long-term run
rate of the economy.

Amid the barrage of nearly constant economic and market data, nothing is
more important to assess the health of corporate America than the quarterly
check-in that we affectionately call earnings season. As earnings season
approaches its halfway mark, it’s a good time to take a look at what we’ve
learned so far.

Only nine times in over 14 years have the
FOMC meeting, GDP report, ISM report, and
the employment report — all often marketmoving
events — occurred in the same week.
Historically, these weeks have exhibited 20%
more volatility than an average week over this
time span, as measured by the S&P 500 Index.
This week is unlikely to be just another boring midsummer
week for financial market participants.​

The latest edition of the Fed’s Beige Book
indicates that the negative headwinds that
have held the U.S. economy back over the
past seven years may be declining.
The rebound in our Beige Book Barometer
over the past several months is consistent
with the Fed’s view that the drop in economic
activity was mostly weather related.
Despite the recent barrage of bad news,
optimism on Main Street remains high...​

If a tax holiday is enacted and the repatriated
funds by multinational corporations are used
to buy back shares or retire debt, it could
potentially act as a very potent market stimulus
equivalent to the height of the Fed’s QE3.

A common worry among investors is that the
stock market may fall as the Fed gets closer
to hiking rates. In fact, the S&P 500 has
posted a gain in the 12 months ahead of the
first rate hikes over the past 35 years.

Global GDP growth in 2014 remains on track
to accelerate versus 2013’s pace, excluding
the impact of the weather.
The pace of growth in the global economy
is a key driver of global earnings growth,
and ultimately, the performance of global
equity markets.
In our view, markets may already be looking
ahead to the second half of 2014, and
especially the third quarter, to gauge the true
underlying pace of global growth.

We continue to expect that U.S. economic
growth may rebound to a 3% pace for all of 2014.
The June 2014 jobs report was undeniably
strong on all fronts, standing in sharp contrast
to the weak performance of the economy in
the first quarter of 2014.
The last time the economy created at least
200,000 jobs per month for five consecutive
months was in late 1999 through early 2000,
when the U.S. economy was growing between
4.5% and 5.0%.

Similar to a farming
almanac, our Investor’s Almanac is a publication containing a guide to
patterns, tendencies, and seasonal observations important to growing.
The goal of farming is not merely to grow crops, but to sustain living
things — investing shares the same goal.

Just as the World Cup has been heating up,
increasing the risk of player mistakes, the
world consumer price index (CPI) has also
been heating up, complicating the task for
policymakers at the world’s central banks and
increasing the risk of mistakes that could have
market implications.

The U.S. economy is poised to outperform
Germany in the years ahead thanks to better
demographics, better productivity, and a more
focused central bank.
Today the U.S. economy is in far better shape
than the German economy. Advantage U.S.A.

We continue to expect the Fed to trim QE by
$10 billion per month this year and to remain
on pace to exit QE by the end of 2014.
Our view remains that the current center of
gravity at the FOMC will likely err on the side
of keeping rates lower for longer.
Markets should expect that the Fed will be
content with keeping its fed funds rate target
near zero until key labor market indicators
make significant progress toward “normal.”

At the heart of it, all markets come down to
buyers and sellers. Taking a look at who is
buying and who is selling can tell us something
about the durability of the market’s performance
and what may lie ahead.

The latest edition of the Fed’s Beige Book
indicates that the negative headwinds that
have held the U.S. economy back over the
past five years may be declining.
The rebound in our Beige Book Barometer
is consistent with the Fed’s view that the
contraction in economic activity was mostly
weather related.
We continue to expect...

As markets brace for this week, we continue
to expect that the U.S. and global economies
may accelerate in 2014 relative to 2013’s
growth rate.
We continue to expect that the FOMC will
taper QE by $10 billion per meeting, exit the
program by the end of 2014, and begin to raise
interest rates in late 2015.
Our view remains that...

We do not think the economic weakness in Q1
is the start of another recession, and, indeed,
we continue to expect real GDP will expand
3.0% in all of 2014.
We believe the conditions are in place for a
pickup in business spending, and we expect
the pace of business capital spending to
accelerate over the next several years.

We do not think the first quarter GDP report will
be a harbinger of a recession in the near future.
We continue to believe the U.S. economy will
accelerate in 2014 (relative to 2013), and that
GDP will increase 3.0% for the year.
The LEI indicates that the risk of recession in the
next 12 months is negligible at 4%, but not zero.

If Godzilla-sized quantitative easing aligns with a
fading impact from recent tax hikes, increasing
political support for corporate tax cuts, and
a push by government pension funds into
stocks, it may mean a blockbuster summer for
Japanese stocks.

The volatility we call “market storms” is likely to continue to be a
characteristic of markets this year, caused by well-known factors, such as:
geopolitical conflict in Russian border countries, slower economic growth
in China, or a weak start to the year for the U.S. economy, among others,
but also lesser-known factors like the Oklahoma earthquakes, solar flares
disrupting communications, and the Ebola outbreak...

While the dollar may gain ground in the coming
months and quarters as the economy accelerates,
we continue to believe the dollar will slowly
depreciate over time — continuing the trend that
has been in place since the early 1970s.
The weaker dollar has, at the margin, made our
exports more attractive, pushed up the costs of
goods we import, and, most importantly...

Key emerging market central banks have
raised rates within the past year in an effort
to combat inflation, the threat of inflation, or
current account imbalances.
Most developed market central banks are on
hold or easing.
The divergence among global central bank
policies creates both risks and opportunities for
global investors, and especially active managers
who invest globally.

Only eight times in over 14 years have the
FOMC meeting, GDP report, ISM report, and the
employment report — all often market-moving
events — occurred in the same week.
Historically, these weeks have exhibited 20%
more volatility than an average week over this
time span, as measured by the S&P 500 Index.
This week is unlikely to be just another boring
mid-spring week for financial market participants.​

Weather was again a key theme in the Beige
Book with 103 mentions, down from 119 in
March. However, the mentions in April were in
a much less negative context than in March.
The Affordable Care Act continues to be a key
concern for Main Street.

This has been the weakest earnings cycle in
55 years. Earnings growth needs to improve to
support valuations and drive the stock market
higher. Fortunately, growth may be set to
improve in the coming quarters.​

The stabilization in growth forecasts for both 2014
and 2015 is a sign that perhaps the market is
more confident now that the global economy is
in the middle innings of an expansion.
While the forecasts for GDP growth for 2014 and
2015 have generally moved higher for developed
economies over the past 18 months, growth
estimates for emerging market economies have
generally moved lower.

The JOLTS data continue to tell a familiar
story: the labor market is healing, but it still
has a long way to go to get back to normal.
Looking around the country at open jobs by
industry, firm size, and pay, it seems like a
good time to be a business and professional
services worker in the South looking for
work in a small-to-medium sized (50 to 249
employee) business.

At any given time, there are always some
bubbly valuations among industries and stocks
that are hot. But overall, looking at valuations,
the party in the stock market may not be just
getting started — but it is not yet close to
being over.

Weather will still be a factor in the March
employment data & the markets may give the economy another
“free pass” for yet another potentially weak
jobs report.
In our view, the Fed would have to see a sharp
slowdown (less than 50,000 jobs per month) or
ramp up (over 300,000 jobs per month) to slow
down or speed up tapering before fall 2014.

The stock, bond, and commodities markets
appear to have priced in a return to a
positive environment for investors consisting
of stronger economic and job growth
accompanied by a return of some mild inflation.​

The Fed’s target for the fed funds rate in the
long term is lower than in prior rate hike cycles.
The market has already priced in Fed rate
hikes beginning in mid-2015.
Sustained growth in real gross domestic
product (GDP) above 3.0% at any time over
the next three years could elicit an earlier start
to rate hikes by the Fed and/or more rate hikes
once they commence.
The Fed’s communication with investors and
the public remains muddled, at best.

As the NCAA basketball tournament gets down
to its own sweet sixteen while the rest of
March plays out, it is a good time to reflect on
the sixteen competing drivers of the markets
that may make for an exciting showdown in the
weeks and months to come. There will likely
be some upsets that result in volatility as these
factors face off against each other.

Markets will soon be asking: When will the
Fed raise rates? What measures of inflation,
employment, and other economic indicators
will the Fed be watching most closely? How
fast will rates rise once rate hikes begin?
We expect the FOMC to revamp its overly
complex statement beginning at this week’s
FOMC meeting.
We continue to expect the FOMC to taper
quantitative easing by $10 billion at each
FOMC meeting this year.

The ECB made a big bet last week that the
Eurozone economy is picking up fast enough
to avoid the need for any further stimulus.
We are not so sure. Until some key catalysts
emerge, the risks to stocks in Europe may
outweigh the rewards.

In early 2014, harsh winter weather has
replaced policy uncertainty as the biggest
weight on the economy.
Our Beige Book Barometer decreased to +62
in March 2014 from +76 in January 2014, as
weather received 119 mentions.
The Affordable Care Act continues to be a key
concern for Main Street.

The market will be especially interested in the
unemployment rate this month, because just
a 0.1% drop to 6.5% pushes the rate to the
Fed’s threshold of 6.5%.
Yellen made it clear last week that the Fed
was in no hurry to raise rates when the
unemployment rate crosses the 6.5% threshold.
In our view, the Fed is not likely to raise rates
until late 2015 or even early 2016.